Luckin Stock Remains Risky Despite Some Good Recent Developments

Luckin Coffee (OTCMKTS:LKNCY) is a better investment now than it was a month ago. However, scandal-ridden Luckin stock is still a risky investment, considering pending investor lawsuits and substantial cash burn.

close up luckin coffee's logo coffee brand in Shanghai, June 2019.
Source: NewsToday / Shutterstock.com

Even though the company managed to escape with just a $9 million fine from Chinese regulators, there is still a securities class action lawsuit in the U.S. District Court for the Southern District of New York that Luckin will have to contend with. That’s not to say that it’s all doom and gloom for the Chinese coffeehouse chain.

Luckin is finally concentrating on drumming up sales from its existing consumer base, and its legal troubles in China seem to be subsiding. That puts it in better shape than after the crisis, but there are still question marks regarding its future. Hence, Luckin stock is not out of the woods as yet.

Luckin Stock Is in Better Shape Since the Scandal

When I last wrote about Luckin stock, I was pretty much convinced that this was a company you should stay away from. Although that sentiment hasn’t changed, there are certainly some initiatives that Luckin is taking to appease investors that should hold it in good stead. Again, as I mentioned earlier, it will take a lot to satisfy American investors, which have a different attitude towards fraud than their Chinese counterparts. But at this point, there is little that Luckin can do but pick up the pieces and start afresh.

It appears to be doing just that. Previously, Luckin focused on increasing its store count and deriving revenues from the new coffeehouses propping up. However, the company has scrapped that idea and is now concentrating on its existing consumer base. Although it’s a prudent strategy, time will tell if it will bear fruit. Considering the PR disaster surrounding the fraud case, the company needed to go into overdrive in trying to salvage its image.

Unfortunately, present circumstances do not allow it to do so. Luckin has just $780 million cash in hand after burning through over $700 million from Q4 2019 to Q2 2020. These are hardly the circumstances for a company to push for more significant marketing expenses. Also, Luckin cant tap the debt and equity markets, considering the scandal. That means Luckin has to make do with whatever cash it has.

Changes at the Top

Let’s talk about how we got here. Luckin often touted as China’s answer to Starbucks (NASDAQ:SBUX), IPO’ed with great fanfare in May last year. Already a very exciting company in its home country, China, it was now aiming to make inroads into the American markets. An ambitious plan, but it makes more sense if you consider it was working with Alibaba Group (NYSE:BABA) in this endeavor.

We looked set to have a monumental battle between Starbucks and Luckin Coffee. But a $300 million fraud and subsequent revelations regarding how the company was run put an end to the journey. Shares tanked, leading to delisting from NASDAQ. Luckin stock now trades on the pink sheets, where it’s likely to remain for the foreseeable future.

Naturally, when the scandal emerged, investors and analysts questioned those at the top. This led to a much needed clean up of the board, including several high ranking executives. Co-founder and former chairman Charles Lu also stepped down from his position after it emerged that the company poured money into several companies associated with his friends and acquaintances. The clean up will lead to a boost in investor confidence. Apart from the high profile exits, the reappointment of Sean Shao is also a positive development. Shao led a special committee that investigated the fraudulent transactions at the company.

Meanwhile, Marcum Bernstein & Pinchuk is appointed as the new auditor for the company. The new firm replaced the Chinese member firm of Ernst & Young, Ernst & Young Hua Ming. Considering the number of accounting scandals, audit firms are always under the hammer when detecting fraud. Despite the name involved, confidence in Ernst & Young Hua Ming is at an all-time low. So replacing the audit firm is the right step.

Summing Up

Luckin has made some positive strides in the right direction. However, the substantial cash burn that the company is incurring, and a hazy legal battle in the U.S. means that Luckin’s prospects remain hazy.

The company deserves brownie points for trying to clean up the issues that caused this scandal. That will help instill confidence in investors. But Luckin needs to dig in and try to maximize revenues from its existing store count.

Its a long, arduous road to recovery for Luckin. The good news is that at least they’ve started their journey.

On the date of publication, Faizan Farooque did not have (either directly or indirectly) any positions in the securities mentioned in this article. 

Faizan Farooque is a contributing author for InvestorPlace.com and numerous other financial sites. He has several years of experience analyzing the stock market and was a former data journalist at S&P Global Market Intelligence. His passion is to help the average investor make more informed decisions regarding their portfolio.


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